What happened:
Last week Silicon Valley Bank (SVB) collapsed sending the financial markets into a frenzy of worry as concerns of a repeat of the global financial crisis began to emerge; after all, this was the largest bank failure since the 2007-08 financial crisis. Thankfully, over the weekend the US government and related agencies stepped in to provide the much-needed backstop to SVB depositors, which helped remove the fear of contagion across the entire financial system.
How did this happen:
SVB were founded in 1983 in California to focus on the needs of start-up companies. On the eve of their collapse, they had become the 16th largest bank in the United States, being the favoured bankers and providers of capital for technology related start-ups.
Over the last decade, the financing world had become accustomed to cheap money, as interest rates remained at or near zero percent. During the pandemic years of 2020 and 2021, the technology sector received an enormous boost in demand and start up opportunities rocketed higher. SVB provided loan capital to these companies and used depositors capital to invest into billions of dollars of longer dated, typically safe assets, such as Treasuries and Mortgage-Backed Securities. The business model worked well, for as long as interest rates remained at or close to zero and start-ups were raking in the profits as the pandemic era business flowed.
However, 2022 marked a sea change as inflation took hold and the Federal Reserve aggressively raised rates. The sharply higher interest rates impacted the technology sector that saw their valuations drop and business flows slowed significantly. These start-up companies therefore became more reliant on their deposits to meet their ongoing liabilities. However, those deposits had been invested by SVB into long dated assets, which whilst typically regarded as less risky, had over the course of 2022 fallen dramatically in value as interest rates rose. This forced the bank to sell these assets before maturity at depressed prices, locking in large losses on their financials. As SVB clients grew concerned that they might not be able to access their deposits, the outflows began, until a run on the bank ensued last week. SVB quickly become insolvent, and the government interventions quickly followed.
Has the threat been contained?
The US government has intervened and stated that they will backstop the SVB bank depositors regardless of deposit value, which has calmed the SVB situation down. The larger banking institutions are in a strong position, adhering to the strict banking rules that help prevent this from happening to them. The unique business model of SVB, their concentration on technology start-ups and their longer dated bond investments, meant interest rate rises were a negative for them. Whereas other larger banks are much more immune given diversified businesses and a much more conservative bond investment book; interest rate rises are typically positive for these banks. That said there is a possibility that other small regional banks could fail for idiosyncratic reasons similar to SVB; however, these will not pose a threat to the US financial system especially with the US government backstop. The bank sector as whole is in a much better position that on the eve of the financial crisis in 2007.
Casterbridge exposure to SVB.
Casterbridge bespoke portfolios had no direct equity exposure to SVB. Indirectly there were minimal exposures through certain exchange traded and mutual funds. The affected exchange traded funds were the iShares MSCI World and the iShares S&P 500 ETFs, which as of 28 February 2023 had negligible exposures to SVB of 0.03% and 0.05% respectively. One mutual fund in the SI range, had an exposure of 1.53% and in the DPIP portfolio range one fund had a 0.26% exposure. The Casterbridge focus on strong internal research processes and quality, ensures that we are able to minimise or better avoid these idiosyncratic risks.
Important Information
This article is for information only and does not constitute advice or recommendation and you should not make any investment decisions based on it. The views and opinions of this article are those of Casterbridge at the time of writing and may change without notice. Any opinions should not be viewed as indicating any guarantee of return from investments managed by Casterbridge nor as advice of any nature. It is important to remember that past performance and the value of an investment, and any income from it, may go down as well as up and the investor may not get back the original amount invested.
